Facebook Stock Collapse Contributes To Mistrust Of Wall Street

Facebook shares are melting down again on Tuesday, and though the rest of the stock market doesn't seem to care, it should: This episode will likely further cement Main Street's hatred and distrust of Wall Street.

That's because the Facebook IPO had examples of pretty much everything that is wrong with the stock market today. Media and analyst cheerleading? Check. The destructive influence of high-speed trading? Check. A system built for insiders to profit while retail investors pick up scraps? Duh.

"This constantly erodes the confidence of the average investor," said Joseph Saluzzi, co-head of stock trading at Themis Trading. "It's why we see money coming out week after week from stock mutual funds. People are tired, frustrated with it."

Facebook's stock price was down Tuesday more than 4 percent to less than $33 a share. After months of hype leading up to the social network's initial public offering, the stock is down 14 percent from its IPO price of $38 and nearly 28 percent from its $45 peak on Friday, its first disastrous day of trading. The company has lost about $15 billion in artificially inflated paper market value in less than three days. Update: Things got a lot uglier after we filed this post: The stock ended trading Tuesday down nearly 9 percent at $31. That's an 18 percent decline from the IPO price and a 31 percent drop from its peak price on Friday.

Right out of the gate on that first day, there were problems with Nasdaq's handling of the IPO. The exchange was swamped by a flood of orders, including a flurry of canceled orders, from high-frequency trading robots, the Financial Times reported. The technical hangups delayed the start of trading by about half an hour and left many traders in the dark about whether their orders to buy shares had been accepted.

Frightened and confused, potential buyers stepped back, forcing underwriter Morgan Stanley to jump into the market and keep Facebook stock afloat at $38. Since then, Morgan Stanley has apparently either given up supporting the stock or has run out of the dry powder to save it.

But high-frequency traders are still going strong. More than 570 million shares of the stock changed hands on its first day of trading, followed by more than 160 million on its second, and it's on pace for another 100 million-share day.

That is abnormally high trading volume under anybody's definition. It suggests to Saluzzi of Themis Trading that high-frequency traders are using the stock for a plaything -- and will keep doing so for a while to come, particularly with more shares hitting the market as IPO lockups expire in the months ahead.

"When a stock is this volatile, it's very profitable for a short-term trader to zip in and out of it," Saluzzi said.

That means any retail investor thinking of picking up Facebook at what may seem like a bargain had better be prepared to endure a Robot Olympics for what could be several months before a truer picture of Facebook's value emerges. Estimates of the stock's true price range from $30 (according to Pivotal Research Group, which slapped the first-ever "sell" rating on the stock on Friday), to less than $10 (according to Edward Krudy and David Gaffen of Reuters).

But it's not just the robots that can lead to investor distrust. The humans don't seem to be holding up their end of the bargain, either. Financial news media, analysts, bankers and venture capitalists drove interest in Facebook's IPO to a frenzy, urging investors to ignore the many plain warnings that the company was going to be overvalued, that its growth might be slowing down and that it would struggle to make money off mobile users. This has echoes in the willfully ignorant cheerleading we saw during the first tech stock bubble, during the housing bubble and throughout the financial crisis.

Meanwhile, Facebook's IPO appears to have been rigged to the benefit of insiders -- only enhancing suspicions that retail investors already have about the entire stock market.

Companies like Facebook are increasingly taking longer to go public, giving insiders more of a chance to milk the company of easy profits and leaving less for retail investors when the company finally hits the market.

As the New Yorker's John Cassidy writes, this isn't necessarily evil: After all, the company couldn't have succeeded in the first place without those insiders. But this will make it harder for retail investors to trust IPOs in the future, and that's bad news for the whole economy, Cassidy warns:

[T]he I.P.O. system only works if it preserves a balance between public and private investors. If this balance is upended, and virtually all of the rewards are reserved for insiders, ordinary investors will refuse to play the game.

Potentially far more insidious, analysts for three of Facebook's IPO underwriters, Morgan Stanley, JPMorgan Chase and Goldman Sachs, all cut their estimates for Facebook revenue just days before the IPO, Reuters reports. The news was not widely disseminated and may have contributed to the stock's collapse.

Again, the cutting of the estimates is not necessarily evil, and in fact is a sign that the Chinese wall separating analyst research from investment banking is holding up. That's a good thing. What could be a problem is if this information was not properly disclosed to investors ahead of the IPO. None of the three investment banks would comment to Reuters about the analyst estimates.

Even if no laws were broken, the estimate cuts just ahead of the IPO shocked Wall Street mavens, many of whom said they had never seen such a thing happen before. And they could give average investors, who had been worked into a frenzy over Facebook stock, just one more reason to walk away from the whole game.

Securities and Exchange Commission chief Mary Schapiro, talking to reporters after testifying at a Senate Banking Committee hearing investigating another trading disaster, JPMorgan's multi-billion-dollar trading loss in credit derivatives, said that regulators should look into issues surrounding Facebook's IPO. But she also suggested that investors should stay confident in U.S. financial markets.

"I think there is a lot of reason to have confidence in our markets and in the integrity of how they operate," she reportedly said.